Anda di halaman 1dari 93

AUDITING

A RISK-BASED APPROACH
TO CONDUCTING A
QUALITY
AUDIT
9th Edition
Karla M. Johnstone | Audrey A. Gramling | Larry E.
Rittenberg

Chapter 10
Auditing Cash and
Marketable Securities

Copyright 2014 South-Western/Cengage Learning

Learning Objectives
1.

2.

3.

4.

Identify the significant accounts,


disclosures, and relevant assertions in
auditing cash accounts
Identify and assess inherent risks of
material misstatement in cash accounts
Identify and assess fraud risks of material
misstatement in cash accounts
Identify and assess control risks of
material misstatement in cash accounts
10-2
Copyright 2014 South-Western/Cengage Learning

Learning Objectives
5.

6.

7.

Describe how to use preliminary analytical


procedures to identify possible material
misstatements for cash accounts,
disclosures, and assertions
Determine appropriate responses to
identified risks of material misstatement for
cash accounts, disclosures, and assertions
Determine appropriate tests of controls and
consider the results of tests of controls for
cash accounts, disclosures, and assertions
10-3
Copyright 2014 South-Western/Cengage Learning

Learning Objectives
8.

9.

10.

Determine and apply sufficient appropriate


substantive audit procedures for testing cash
accounts, disclosures, and assertions
Identify types of marketable securities,
articulate the risks and controls typically
associated with these accounts, and outline an
audit approach for testing these accounts
Apply frameworks for professional decision
making and ethical decision making to issues
involving the audit of cash accounts,
disclosures, and assertions
10-4
Copyright 2014 South-Western/Cengage Learning

THE AUDIT OPINION


FORMULATION PROCESS

10-5
Copyright 2014 South-Western/Cengage Learning

PROFESSIONAL JUDGMENT IN CONTEXT Fraudulent Petty Cash Transactions at Koss


Corporation
Former vice president of finance
orchestrated a $31 million embezzlement
Remediation actions
Eliminating petty cash fund

10-6
Copyright 2014 South-Western/Cengage Learning

PROFESSIONAL JUDGMENT IN CONTEXT Fraud at Peregrine Financial


Embezzlement of over $200 million from
Peregrine Financial Groups (PFG)
brokerage clients over a 20-year period
Bankruptcy filed immediately after
implementation of change in online system
Where bank statement information would be
sent electronically directly to National Futures
Association

10-7
Copyright 2014 South-Western/Cengage Learning

PROFESSIONAL JUDGMENT IN CONTEXT Fraud at KOSS Corporation and Peregrine


Financial
Why is cash an inherently risky account? (LO
2, 3)
What controls should be in place to help
ensure that cash accounts are not
misappropriated? (LO 4)
What are the audit implications of poor
controls over cash accounts? (LO 6)
What types of audit procedures would
auditors employ when auditing cash? (LO 7,
8)
10-8
Copyright 2014 South-Western/Cengage Learning

Learning objective 1

Identify the significant accounts, disclosures,


and relevant assertions in auditing cash
accounts

Major types of cash accounts


General checking accounts
Cash management accounts
Imprest payroll accounts
Petty cash accounts
Marketable security accounts: A
security that is readily marketable and
held by a company as an investment

10-10
Copyright 2014 South-Western/Cengage Learning

Imprest Payroll Accounts


Imprest bank account
Normally carrying a zero balance
Replenished when checks are to be written
against the account
Provides additional control over cash
Payroll account - The most widely used
imprest bank account
Company makes a deposit equal to amount of
payroll checks issued
10-11
Copyright 2014 South-Western/Cengage Learning

BENEFITS OF Cash
Management Techniques
Speed the collection and deposit of
cash

Reduce the amount of paperwork

Automate the cash management


process

10-12
Copyright 2014 South-Western/Cengage Learning

Cash Management Techniques

Lockboxes

Electronic
Funds
Transfers

Cash
Management
Agreements
with
Financial
Institutions

Compensatin
g Balances

10-13
Copyright 2014 South-Western/Cengage Learning

Lockboxes
Cash management arrangement with a bank
whereby payments are sent directly to a post
office box number accessible to clients bank
Bank opens cash remittances and directly deposits
money in clients account

Advantages
Company immediately earns interest on deposited
funds
Manual processing is shifted to bank
Speeds up receipt of cash and allows organization
to use cash to earn a return
10-14
Copyright 2014 South-Western/Cengage Learning

Relevant Financial Statement


Assertions relevant to cash
Existence or occurrence
Cash balances exist at balance sheet date

Completeness
Cash balances include all cash transactions that occurred during
the period

Rights and obligations

Company has title to the cash accounts as of balance sheet date

Valuation or allocation
Recorded balances reflect true underlying economic value of
those assets

Presentation and disclosure

Cash is properly classified on the balance sheet and disclosed in


notes to the financial statements
10-15
Copyright 2014 South-Western/Cengage Learning

Learning objective 2

Identify and assess inherent risks of material


misstatement in cash accounts

Performing Risk Assessment


Procedures for Cash Accounts
Information useful in assessing risk of
material misstatement is obtained
Inherent risks
Financial statement level
Account and assertion level

Fraud risks
Feedback from audit team brainstorming
sessions
Strengths and weaknesses in internal control
Results from preliminary analytical procedures
10-17
Copyright 2014 South-Western/Cengage Learning

Reasons for Identifying cash as


having high Inherent Risk
Volume of activity
Liquidity
Automated systems
Importance in meeting debt
covenants
Can be easily manipulated
10-18
Copyright 2014 South-Western/Cengage Learning

Inherent Risk Analysis


Questionnaire: Cash

10-19
Copyright 2014 South-Western/Cengage Learning

Inherent Risk Analysis


Questionnaire: Cash

10-20
Copyright 2014 South-Western/Cengage Learning

Learning Objective 3

Identify and assess fraud risks of material


misstatement in cash accounts

Topics to be covered in a
brainstorming session

10-22
Copyright 2014 South-Western/Cengage Learning

Auditing in Practice - Common


Fraud Schemes Relating to
Cash

Frauds relating to cash receipts

Inventory sold, but employee does not


record the sale and steals the cash
Employee receives a check and deposits it,
but does not record the sale; then the
employee writes a check out to himself and
does not record the disbursement
Employee collects a customer payment,
steals cash, and writes off accounts
receivable as uncollectible
10-23
Copyright 2014 South-Western/Cengage Learning

Auditing in Practice - Common


Fraud Schemes Relating to
Cash
Lapping: Employee steals a payment from
one customer, and covers it up by using
payments from another customer to
disguise the theft
Skimming: Type of fraud that occurs when
an employee makes a sale but does not
record it, and steals the cash

10-24
Copyright 2014 South-Western/Cengage Learning

Auditing in Practice - Common


Fraud Schemes Relating to
Cash

Frauds relating to cash payments

Purchasing merchandise and recording sale at


an unauthorized discounted amount
Selling merchandise to a friend at a discounted
price; friend returning merchandise for a refund
at undiscounted price; splitting profits
Employee stealing cash and concealing it by
recording a fictitious discount
Employee writing a check to a fictitious vendor
and depositing the check into an account
controlled by the employee
10-25
Copyright 2014 South-Western/Cengage Learning

Learning objective 4

Identify and assess control risks of material


misstatement in cash accounts

Common Controls Over Cash

10-27
Copyright 2014 South-Western/Cengage Learning

Common Controls Over Cash

10-28
Copyright 2014 South-Western/Cengage Learning

Auditing in Practice - The Parmalat


Fraud and Its Many Victims
Evolved over a 10-year period
Included invention of over $11 billion in
fictitious cash in offshore front companies
to offset liabilities at parent company
In reality, cash was not accounted for and
Parmalat had only about 500 million euros
in cash
Involved large number of individuals
acting collusively in various ways
10-29
Copyright 2014 South-Western/Cengage Learning

Implications of Weak Controls


Related to Completeness
Employee required to record a cash receipt
Not performing the task
Not reflecting the cash being received, a
sale made, or reduced accounts receivable

10-30
Copyright 2014 South-Western/Cengage Learning

Auditing in Practice - Skimming


and the Completeness
Assertion
When a transaction is not immediately
recorded, completeness assertion is
violated
Applicable where customers pay cash
directly to an employee

10-31
Copyright 2014 South-Western/Cengage Learning

Controls for Petty Cash


Limiting access by keeping funds in a locked box
Requiring receipts for petty cash disbursements
with:

Date
Amount received
Purpose or use for funds
Name of employee receiving funds

Reconciling petty cash fund before replenishing it


Keeping customer receipts separate from petty
cash funds
10-32
Copyright 2014 South-Western/Cengage Learning

Controls for Cash Management


Techniques
Lockboxes

Electronic funds transfers

Cash management agreements


with financial institutions

10-33
Copyright 2014 South-Western/Cengage Learning

Assessing Control Risk for Cash


Controls minimize potential risks to cash
accounts
Requires the auditor to have an understanding
of internal controls for:
Integrated audits
Financial statement only audits
Understood by:

A walkthrough of process
Inquiry
Observation
Review of documentation
10-34
Copyright 2014 South-Western/Cengage Learning

Assessing Control Risk for Cash


At account and assertion levels, considering:
Entity-wide controls
Transaction controls

At entity-wide level, considering control


environment

Commitment to financial accounting competencies


Independence of the board of directors
Risk assessment
Information and communication
Monitoring controls
10-35
Copyright 2014 South-Western/Cengage Learning

Assessing Control Risk for Cash


Integrated audit of cash involves evaluating:
Design of internal controls
Operation of internal controls

Smaller organizations - Testing of operating


effectiveness of controls is not a required
part of the audit
Larger organizations - Evaluating and
testing of internal controls happen via an
integrated audit
10-36
Copyright 2014 South-Western/Cengage Learning

Control Risk Questionnaire Cash

10-37
Copyright 2014 South-Western/Cengage Learning

Control Risk Questionnaire Cash

10-38
Copyright 2014 South-Western/Cengage Learning

Documenting Controls
Documenting auditors understanding of
internal controls for:
Integrated audits
Financial statement only audits

A questionnaire often used to guide


auditors in documenting understanding of
internal controls

10-39
Copyright 2014 South-Western/Cengage Learning

EXHIBIT 10.3 - Control Activities


Questionnaire: Cash Receipts

10.3 A.png

10-40
Copyright 2014 South-Western/Cengage Learning

Learning objective 5

Describe how to use preliminary analytical


procedures to identify possible material
misstatements for cash accounts, disclosures, and
assertions

Performing Preliminary
Analytical Procedures
Helps identify areas of potential
misstatements when planning the audit
Cash is examined in relation to:
Operational data
Budgetary forecasts

Requires awareness of importance of cash


balances to debt covenants

10-42
Copyright 2014 South-Western/Cengage Learning

Performing Preliminary
Analytical Procedures
Relationships indicating heightened risk of
fraud in cash:
Consistent profits over several years, but
cash flows are declining
Unexpected reductions in accounts
receivable collections, or timeliness of
collections
Unexpected declines in petty cash account

10-43
Copyright 2014 South-Western/Cengage Learning

Using Trend Analysis of Account Balances


and Ratios in Preliminary Analytical
Procedures for Cash Accounts

10-44
Copyright 2014 South-Western/Cengage Learning

Using Trend Analysis of Account Balances


and Ratios in Preliminary Analytical
Procedures for Cash Accounts

10-45
Copyright 2014 South-Western/Cengage Learning

Learning objective 6

Determine appropriate responses to identified risks


of material misstatement for cash accounts,
disclosures, and assertions

Responding to Identified Risks


of Material Misstatement
Audit procedures are proportional to assessed
risks
Areas of higher risk receive more audit
attention and effort

Developing audit approach that contains:


Tests of controls (if applicable)
Substantive procedures, including analytical
procedures

Audit programs are customized based on


assessment of risk of material misstatement
10-47
Copyright 2014 South-Western/Cengage Learning

EXHIBIT 10.5 - Panel A: Sufficiency of


Evidence for Existence and Completeness
of Cash

10-48
Copyright 2014 South-Western/Cengage Learning

EXHIBIT 10.5 - Panel B: Approaches to


Obtaining Audit Evidence for Existence and
Completeness of Cash

10-49
Copyright 2014 South-Western/Cengage Learning

Learning objective 7

Determine appropriate tests of controls and consider


the results of tests of controls for cash accounts,
disclosures, and assertions

Selecting Controls to Test and


Performing Tests of Controls
Auditors make decisions about:
Which controls to test for formulating an
opinion on entitys internal controls
Whether the level of control risk warrants
reduction of substantive testing

10-51
Copyright 2014 South-Western/Cengage Learning

Selecting Controls to Test and


Performing Tests of Controls
Tests of transactions controls
Inquiry of personnel performing the control
Observation of control being performed
Inspection of documentation confirming that
control has been performed
Reperformance of control by individual
testing the control

10-52
Copyright 2014 South-Western/Cengage Learning

Considering the Results of


Tests of Controls
Control deficiencies
identified

No control deficiencies
identified

Assessing those deficiencies


to determine their severity

Determining that
preliminary assessment of
control risk as low is
appropriate

Modifying preliminary
control risk assessment

Determining the extent that


controls can provide
evidence on correctness of
account balances

Documenting implications of
control deficiencies

Determining planned
substantive audit
procedures

10-53
Copyright 2014 South-Western/Cengage Learning

Learning objective 8

Determine and apply sufficient appropriate


substantive audit procedures for testing cash
accounts, disclosures, and assertions

Auditing in Practice - Weaknesses in


Substantive Procedures Related to
Cash
Auditor needs to consider types of
substantive procedures for cash that
should be performed
Make sure that engagement team
performs those procedures
PCAOB disciplinary proceedings against
two audit firms provide insight on
weaknesses in cash-related audit
procedures
10-55
Copyright 2014 South-Western/Cengage Learning

Substantive Analytics for Cash


Accounts
Focusing on substantive tests of details
Minimal substantive analytics to be
performed include identifying significant:
Fluctuations in cash balances
Differences between budgeted and actual
levels of cash

10-56
Copyright 2014 South-Western/Cengage Learning

Substantive Tests of Details for


Cash Accounts
Preparing independent bank
reconciliations

Obtaining bank confirmations and


bank cutoff statements

Preparing bank transfer schedules

10-57
Copyright 2014 South-Western/Cengage Learning

Preparing Independent Bank


Reconciliations
Provides evidence for accuracy of year-end
cash balance
Process includes reconciling balance per
bank statements with balance per books
Auditor independently verifies the
following items when testing clients bank
reconciliation
Balance as per bank
statement
Deposits in transit
Outstanding checks
Other adjustments
10-58
Copyright 2014 South-Western/Cengage Learning

EXHIBIT 10.7 - TESTS OF


CLIENTS BANK
RECONCILIATION

10.7.png

10-59
Copyright 2014 South-Western/Cengage Learning

Bank Confirmation
A standard confirmation sent to all banks with
which the client had business during the year
Used to obtain information about year-end
cash balance and additional information
about loans outstanding
Seeks information on:
Clients deposit balances
Existence of loans
Due dates of loans
10-60
Copyright 2014 South-Western/Cengage Learning

Bank Confirmation
Interest rates
Dates through which interest has been paid
Collateral
An asset or a claim on an asset held by a
borrower or an issuer of a debt instrument
To serve as a guarantee for value of a loan or
security
If the borrower fails to pay interest or
principal, collateral is available to lender to
recover principal amount of loan
10-61
Copyright 2014 South-Western/Cengage Learning

EXHIBIT 10.8 - Standard Bank


Confirmation: Account Balances

10.8.png

10-62
Copyright 2014 South-Western/Cengage Learning

Auditing in Practice Confirmations with Financial


Institutions
PCAOB-proposed Auditing Standard would
require auditor to:
Perform confirmation procedures for cash
and other relationships with financial
institutions

10-63
Copyright 2014 South-Western/Cengage Learning

OBTAINING BANK
CONFIRMATIONS LOAN
GUARANTEES

These requirements are referred to as


covenants
A violation of covenants makes loans
immediately due and payable

Considering clients ability to continue to


operate as a going concern
In case of a long-term debt, reclassifying it
as a current liability

10-64
Copyright 2014 South-Western/Cengage Learning

EXHIBIT 10.9 - Standard Bank


Confirmation: Loan Guarantees

10.9.png

10-65
Copyright 2014 South-Western/Cengage Learning

Obtaining Year-End Cutoff


Information as Part of Bank
Confirmation Process
Obtaining information on last checks
issued in fiscal year
Last check number

Observing that all previous checks had


been mailed
Obtaining information on last cash receipts

10-66
Copyright 2014 South-Western/Cengage Learning

Cutoff Bank Statements


A statement for a period of time
determined by client and auditor
Shorter than that of regular month-end
statements
Sent directly to auditor, who uses it to
verify reconciling items on clients yearend bank reconciliation

10-67
Copyright 2014 South-Western/Cengage Learning

Preparing Bank Transfer


Schedules
Kiting: Fraudulent cash scheme to overstate
cash assets at year end by showing the
same cash in two different bank accounts
Bank transfer schedule: Audit document
listing all transfers between client bank
accounts
Starts shortly before year end and continues
for a short period after year end
Purpose - Assures that cash in transit is not
recorded twice
10-68
Copyright 2014 South-Western/Cengage Learning

Fraud-Related Substantive
Procedures for Cash Accounts
Confirming with financial institutions about
individuals authorized to access cash accounts
Scrutinizing checks that are payable to cash
Scrutinizing checks with unusual vendor
names
Scrutinizing checks made out to employees
outside of normal payroll processing system
Comparing timing of deposits into bank
accounts with timing of cash receipts
Noting any unusual time lags
10-69
Copyright 2014 South-Western/Cengage Learning

Fraud-Related Substantive
Procedures for Cash Accounts
Comparing time lags between:
The date a check was issued for payment
The date that it clears the bank

Investigating voided checks and analyzing


voided transactions

10-70
Copyright 2014 South-Western/Cengage Learning

Documentation related to
Substantive Procedures for cash
accounts
Copies of independent bank reconciliations
Copies of bank confirmations
Documentation of oral confirmations
Copies of bank cutoff statements
Copies of bank transfer schedules
Evidence of any restrictions on use of cash
balances or bank compensating balances

10-71
Copyright 2014 South-Western/Cengage Learning

Learning objective 9
Identify types of marketable securities, articulate the risks
and controls typically associated with these accounts, and
outline an audit approach for testing these accounts

Marketable securities
Held as temporary investments
Short-term cash management securities
U.S. Treasury bills
Certificates of deposit (CDs)
Commercial paper
Notes issued by major corporations at rates
approximating prime lending rates with high
credit rating

Short-term hybrid-type securities


Improve return on temporary investments
10-73
Copyright 2014 South-Western/Cengage Learning

Classification of investments in
securities
Held-to-maturity
securities

Valued at amortized cost,


subject to an impairment
test

Trading
securities

Carried at fair market value

Available-forsale securities

Carried at fair market value

10-74
Copyright 2014 South-Western/Cengage Learning

AUDITORS JUDGMENTAL
CHALLENGE
Corroborating managements intent in
classifying assets
Gathering information about managements
trades in investments
Importance of market value to management
compensation

Determining fair market value


Easily determinable for regularly traded
securities
Financial institutions reluctant to mark fair
values for thinly traded securities
10-75
Copyright 2014 South-Western/Cengage Learning

Relevant Financial Statement


Assertions
Existence or
occurrence

Securities exist at balance sheet date

Completeness

Securities balances include all


securities transactions taken place
during the period

Rights and
obligations

Company has title to such securities


accounts as of balance sheet date

Valuation or
allocation

Recorded balances reflect true


underlying economic value of those
assets

Presentation
and disclosure

Properly classifying the securities on


balance sheet and disclosing in notes
to financial statements
10-76

Copyright 2014 South-Western/Cengage Learning

Inherent and Fraud Risks


Risk of sudden market declines

Manipulation of classification of
securities

Manipulation of valuation of fair


market value
10-77
Copyright 2014 South-Western/Cengage Learning

Control Risks
Risk of theft of securities if:
They are not physically controlled
Authorization and monitoring over their trade is
not effective

Lack of policies over purchase or sale of


securities
Lack of monitoring of changes in securities
balances
Lack of policies over valuation or classification
of securities
10-78
Copyright 2014 South-Western/Cengage Learning

Control Risks
Lack of segregation of duties between
those responsible for:
Making investment decisions
Custody of securities

Lack of involvement or oversight by


internal audit in relation to securities

10-79
Copyright 2014 South-Western/Cengage Learning

INHERENT RISK ANALYSIS


QUESTIONNAIRE - MARKETABLE
SECURITIES

10-80
Copyright 2014 South-Western/Cengage Learning

Control Risk Analysis


Questionnaire - Marketable
Securities

10-81
Copyright 2014 South-Western/Cengage Learning

Control Risk Analysis


Questionnaire - Marketable
Securities

10-82
Copyright 2014 South-Western/Cengage Learning

Auditing in Practice - Common


Fraud Schemes Relating to
Investments
Securities purchased, not authorized
Securities purchased, not recorded as purchased
Securities recorded as purchased, not purchased
Securities sold, not recorded as sold
Securities recorded as sold, not sold
Investment income is stolen
Investments are purposely valued inaccurately
Investment classifications are purposely
inaccurate

10-83
Copyright 2014 South-Western/Cengage Learning

Analytical Procedures for


Marketable Securities
Developing expectations about level of
amounts in ending balances
Based on purchase or sales activity reported

Developing expectations about relationship


between balances in marketable securities
accounts
Reviewing changes in:
Balances
Risk composition
Classification types of marketable securities
10-84
Copyright 2014 South-Western/Cengage Learning

Tests of Controls
Reviewing policies for authorization
To purchase, sell, and manage such securities

Inquiring of board of directors about boards


oversight of process and examining related
documentation
Examining documentation of authorization
For selected purchases and sales

Reviewing minutes of board meetings


For reference to investment policies and
associated oversight
10-85
Copyright 2014 South-Western/Cengage Learning

Tests of Controls
Examining evidence of authorization controls
For changes in classification of such securities

Inquiring of management about its process for


Establishing valuation
Reviewing related documentation

Inquiring about process for reclassifications


and review related documentation

10-86
Copyright 2014 South-Western/Cengage Learning

Tests of Controls
Examining documentation for selected
marketable securities transactions
Reviewing reports of internal audit

10-87
Copyright 2014 South-Western/Cengage Learning

Assertions and Related Substantive


Tests of Details - Marketable Securities
Existence or occurrence
Requesting for a schedule of securities and verifying their
existence

Completeness
Footing schedule of marketable securities and examining them

Rights and obligations


Examining selected documents to determine any restrictions

Valuation or allocation
Determining current market value
Re-computing interest and proper recording of accrued
interest

Presentation and disclosure


Determining whether securities are properly classified
10-88
Copyright 2014 South-Western/Cengage Learning

EXHIBIT 10.15 - audit workpaper


for testing marketable equity
securities

10.15.png

10-89
Copyright 2014 South-Western/Cengage Learning

Auditing in Practice - Audit Procedures Used to


Address Risk Related to Common Fraud Schemes for
Investments

Employing specialist to assist in fair value


measurements
Conducting background checks of
employees having access to investment
accounts
Requiring original documents of securities
Tracing:
Dividend payments
Interest payments
Sales of securities
10-90
Copyright 2014 South-Western/Cengage Learning

Auditing in Practice - Audit Procedures Used to


Address Risk Related to Common Fraud Schemes for
Investments

Tracing purchases of securities to cash


disbursements on the bank statement
Reviewing any unusual journal entries in
investment accounts

10-91
Copyright 2014 South-Western/Cengage Learning

Documentation related to substantive


procedures for marketable securities
Schedule of marketable securities as:
Prepared by client
Reviewed by auditor

Documentation of any confirmation of securities


Documentation of securities transactions
scrutinized
Memo containing rationalization for judgments
about managements:
Classification of securities
Valuation of securities
10-92
Copyright 2014 South-Western/Cengage Learning

Documentation related to substantive


procedures for marketable securities
Reports of any outside valuation experts
Documentation of calculation of potential
impairments

10-93
Copyright 2014 South-Western/Cengage Learning